A decade-long shift in market behavior from individual investors buying municipal bonds to larger institutional buyers suggests a long-term trend of increased use of separately managed accounts, exchange-traded funds and mutual funds.
A report published by the Municipal Securities Rulemaking Board Wednesday found a noticeable shift in market behavior with a significant decline in individual investor purchases and an increase in institutional purchases of municipal securities. That trend is here to stay, sources say.
“It helps to confirm that this is less than a temporary trend,” said Matt Fabian, partner at Municipal Market Analytics. “It’s an important development for bondholders and for investors because it’s really analogous to what we’ve been calling the institutionalization of demand that leads to structurally tighter spreads in all forms as a secular factor.”
Over the last decade, customer purchases of fixed-rate, tax-exempt municipal securities of $100,000 or less decreased by 46%, the MSRB found. Meanwhile, institutional-sized purchases of over $1 million increased 46% in the same time period.
“There were notably more customer purchases of over $1 million and notably fewer customer purchases of $100,000 or less over the past decade, while customer sales and interdealer trades remained relatively stable,” the MSRB said. “It is possible that increased use of separately managed accounts (SMAs), mutual funds and exchange-traded funds (ETFs) has replaced some direct individual investor transactions, driving the shift in the size of customer purchases.”
In 2020, the number of purchases of tax-exempt securities of $100,000 or less accounted for 77.8% of all customer purchases compared to 87.2% in 2010. For larger block trades of over $1 million, they account for 4.6% of customer purchases in 2020, compared to 1.9% in 2010.
In 2020 there were 9% more institutional-sized trades of all municipal securities than in 2010 and 22% fewer individual investor-sized trades, the MSRB said.
Over the years, many large brokerage firms and asset managers have looked to reduce risk from their clients’ portfolios and encouraged their retail clients to give them control over the buying and selling process, Fabian said. Increased regulation in how firms treat their retail clients has encouraged firms to move client money from transactional accounts to discretionary accounts.
“Most of the large retail managers have moved clients from traditional, transactional, retail accounts into discretionary platforms like SMAs,” Fabian said. “The firm itself then makes the allocation decisions and is, therefore, less responsible for making sure that the client understands their investment decision.”
The shift to institutional also means that lower-rated bonds are less available. A typical retail investor may worry about default risk, but the typical institutional investor would take on that risk and know that there isn’t a real default increase between a triple-B and a triple-A in the municipal sector.
“Institutional investors have a better understanding of risk,” Fabian said. “Municipals are easy to love but hard to understand.”
The decrease in individual investors buying municipal bonds independently does not mean less interest in their purchases of tax-exempt municipal bonds, said Patrick Luby, a municipal strategist at CreditSights.
“IRS data on individual tax returns shows us that over the last couple of years the number of taxpayers reporting tax-exempt interest has grown,” Luby said.
